In Sri Lanka, talk of a manufacturing economy often begins only when the country is in economic trouble. The promotion of industry as a government policy was very slow due to the lack of a commitment by the authorities and the lack of knowledge among the people. As a result, the automobile manufacturing/assembly and automotive component manufacturing industry sprang up, but it faltered.
Although the history of the industry goes back to 1980, the industry was not fully supported until the end of 2020. It was in that, the Ministry of Industries along with other Ministries and Departments introduced a Standard Operating Procedure (SOP) related to the assembly/manufacturing of automobiles and manufacturing of automotive components.
Role of the Ministry of Industries
Based on the government’s policy of taking Sri Lanka to a manufacturing economy, the Ministry of Industries has been entrusted with the lead role in the development of the country by developing the local manufacturing industry sector. For this purpose, twenty manufacturing industries have been identified, among which automobile assembly/manufacturing and automobile component manufacturing take a leading role.
A Consultative Committee on the production and assembly of automobile components related to this industry has also been established by the Ministry of Industries with members representing the industrialists engaged in this industry.
Standard Operating Procedure and its legal status
Vehicle assembly/production took place in Sri Lanka from time to time. However, with the aim of regulating and promoting the industry, a Standard Operating Procedure (SOP) was prepared only in 2020, incorporating the opinions of experts in the field and in accordance with international standards. It was submitted to the Cabinet on 16/12/2020 and received Cabinet approval on 11/1/2021. It was confirmed by the letter Ref. 20/205/320/012-01 dated 19/01/2021 from the Cabinet of Ministers.
It has been legally enacted by Gazette No. 2222/3 of 04/05/2021.
The main factors that led to the implementation of the standard operating procedure is the large amount of foreign exchange that goes out of the country for the import of vehicles and the need to ensure a minimum vehicle requirement for the country, following the suspension of vehicle imports due to the Corona epidemic.
However, the broader objectives were,
(i) To enable any local and foreign investor to invest in the country’s vehicle manufacturing/assembly industry with credibility.
(ii) Rapid promotion of auto component manufacturing industry by the introduction of formulae and an agenda for the local value-addition. (DVA formula & XID Metrix)
(iii) Bringing internationally recognized modern technology into the country based on vehicle assembly industries and component manufacturing industries and promoting research and development departments in universities and technical colleges.
(iv) Training tens of thousands of technical officers and engineers related to engineering and technology subjects and providing employment after training or providing training as necessary for them to work abroad for higher salaries.
Manufacturing and assembly
The manufacturing and assembly of vehicles are two internationally recognized methods. Assembly is done in several ways. The two main methods are,
(i) CKD : Complete Knocked-Down (Assembly from Completely Knocked-down components)
(ii) SKD : Semi Knocked-Down (Assembly from Semi Knocked-Down Components)
These are the two methods accepted in Sri Lanka, and both methods are used by local assembly companies.
Companies that assemble vehicles locally, under an agency agreement with an internationally recognized vehicle manufacturer brand, import a particular vehicle model produced by that company for local assembly under these two methods.
The vehicle identification number or (VIN) number is given by the original manufacturer of the vehicle. It is clearly stated in the SOP on Page No. 4 under Clause No. 1.2.5.
Assembling a vehicle locally
To assemble a vehicle locally, first the local assembly company should follow the following steps.
- The company must be registered with the Department of Motor Traffic.
- It should be registered as an industrialist with the Ministry of Industries. (For this, there are several conditions that must be fulfilled by the company.)
- A Comprehensive Concept Paper should be given to the Ministry of Industries in respect of the vehicle model that is expected to be assembled by the company. After an initial evaluation by the technical committee, it should be submitted to the committee of experts appointed by the Cabinet of Ministers (Cabinet appointed committee).
- After the report is approved, the institution should provide the ministry with a description of the components it intends to import from abroad as well as a description of the components it intends to add locally.
Local value addition and recommendation
More than twenty percent (20%) of the Ex-Factory Cost of the assembled vehicle must be from locally produced components. (What constitutes a local product is clearly specified in the SOP.) The local assembly company is not allowed to add imported components bought from the local market and try to prove that they have added more than 20% value. The local value-addition is monitored and the recommendation process is done under a very scientific and transparent method. After receiving Model Approval for the vehicle that is assembled, the company must provide the details of the components obtained locally, to the Ministry of Industries. Then the calculation of the local value of each component is assessed separately. This work is done by the following institutions:
(I) Industrial Development Board
(II) National Engineering Research & Development Centre (NERDC) of Sri Lanka
(III) National Apprentice and Industrial Training Authority
Officials of these institutions will confirm the amount of local value-addition after a physical inspection of the component’s technical design, Bill of Quantities (BOQ) and prototype, in addition to the manufacturing process of the component. There is no opportunity for the manufacturer to confirm the local value-addition just by mentioning that local components have been used. Only the Minister of Industries has the authority to recommend the value-addition after a complete inspection and certification by these institutions. Only then is it possible to get the relevant tax exemption. A vehicle model is not eligible for tax exemption other than through this process.
How is the tax exemption granted?
The calculation and collection of tax on vehicles assembled using components supplied by a foreign manufacturer as well as those manufactured locally, are based on the Sri Lanka Excise Special Provisions Act No. 13 of 1989, and its amending Acts Excise (Special Provisions) (Amendment) Act (No. 40 of 1990), Excise (Special Provision) (Amendment) Act (No. 8 of 1994) and Customs Ordinance. According to the power vested in the Minister of Finance under Excise (Special Provision) (Amendment) Act (No. 8 of 1994) Amendment Act) 03 (c) (1) as per Gazette No. 2346/36 (31/12/2021). The amounts of excise duty to be charged at the time of removal of a vehicle from the bonded warehouse are indicated on pages 55A and 56A of the Gazette, where this tax relief is available only for excise duties and the duties governed by the Customs Ordinance are paid in full. (E.g. full payment of tax on value-added.) This tax exemption is available only to assemblers who are able to prove local value-addition as mentioned above.
Bringing of imported goods into bonded warehouses and their assembly
Imported auto parts are brought into bonded warehouses for local value-addition and assembly. For this bonded warehousing facility, the assembling companies shall apply and the bonded warehousing facility will be provided as per Section 69 of the Customs Ordinance. It is also stated under 84A (1) of the Customs Ordinance that goods can be brought into bonded warehouses for manufacture or assembly. They are brought into bonded warehouses as spare parts. In the bonded warehouse, the manufacturing of vehicles takes place using locally manufactured components as well, and at the end of the process a vehicle is produced.
The components that come into the bonded warehouse as components are transformed into a vehicle after undergoing a process. It cannot be said that the basic characteristics of the vehicle were there at the time of bringing in the components. When the parts of a vehicle are taken individually, the body shell, engine, gearbox or steering wheel cannot be shown as a vehicle. And the utility from a vehicle cannot be obtained from any of these components by themselves. They remain only as components.
Luxury Tax
According to Gazette No. 2113/11 on 05 March 2024, starting from March 6, 2019, specific motor vehicles are subject to luxury taxes. The tax is imposed on these vehicles when their cost exceeds the luxury tax-free threshold, and it is applicable only on the amount that exceeds this threshold in each vehicle category.
When determining the luxury tax-free threshold, for imported complete vehicles, the CIF value is considered. However, for locally assembled vehicles, the threshold is calculated based on the Ex-factory cost, which includes not only the CIF value of the body shell and parts but also the cost of locally added components & local production overheads. As a result, locally assembled vehicles are subject to a much higher luxury tax compared to vehicles imported in complete form. Additionally, the cost of each batch of locally assembled vehicles is verified by a Chartered Accountant and undergoes further verification by the Technical Committee appointed by the Cabinet Appointed Committee for Local Vehicle Assembly. Therefore, the Ex-factory cost used to calculate luxury tax for locally assembled vehicles is considered the most reliable tax base, while the CIF value used for reconditioned vehicles can be manipulated to reduce the luxury tax.
Operational Cost of Assemblers
Companies involved in the local assembly industry in Sri Lanka are well-established and reputable corporations that operate nationwide and employ a significant number of staff members. These operations must adhere to international guidelines set by vehicle manufacturers. Consequently, the operational cost of these companies is significantly high, and their financial statements reflect a substantial amount of financial cost incurred in previous years. Therefore, assessing the profitability of these companies solely based on gross profit levels is a misleading mechanism.
Statutory Requirements for Assemblers
In addition to registration at the Ministry of Industries, local vehicle assembly companies must be properly registered under specific government authorities, including the Inland Revenue, RMV, and the Industrial Development Board (IDB). These companies are required to fulfill the regular compliance requirements set by these government authorities. Furthermore, these companies undergo independent audits annually, demonstrating that their business is conducted in a faithful manner.
Tax Compliances of the Vehicle Assemblers
As mentioned earlier, vehicle assemblers are properly registered corporations at the Department of Inland Revenue and must comply with all tax compliance requirements. They are required to adhere to the stipulated tax payments and filing of specified tax returns. Other than import taxes, these companies contribute over 48% of their margins as taxes to the government, including taxes such as VAT and income tax. This fact should be highlighted when analyzing the true contribution of these companies to the national interest.
Employment Generation
Government statistics indicate that the local assembly industry has generated over 3,200 direct and indirect employment opportunities in the last few years, and it has helped secure around 5,000 direct employees of the companies involved in the motor vehicle business & over 20,000 indirect employees who attached to support services of these companies. The government’s initiative of developing local vehicle assembly has been a lifeline for these companies and their employees during the economic crisis and in the absence of completely built motor vehicle imports.
